Are There Other 401 Options
Withdrawal is not the only way to access 401 funds for a down payment.
Your benefits provider may also offer 401 loan options. If available, this option not only helps you avoid the early withdrawal penalty fee, but also paying income tax on your withdrawal.
401 loans let you borrow up to 50% of your vested account balance Taking out this type of loan puts your 401 account on hold for the duration of the loan you wont be able to make additional contributions until the money is paid back.
But how can you calculate whether the 401 loan is a smart financial decision? As with any lending scenario, the price you pay to borrow the money has a big impact on determining whether the loan is worth it. You can typically expect a 1%-2% spike above the prime rate for these types of loans. Another factor to consider has to do with your employment. If youre unable to pay back the loan on time or before leaving/losing your job, you may be subject to the same financial penalties that come with a withdrawal.
Roth Ira Withdrawal Rules
Most early withdrawals from a tax-advantaged retirement account before age 59 ½ cost you taxes and a 10% penalty, says Jeffrey Levine, certified public accountant and the director of advanced planning with Buckingham Strategic Wealth.
But with a Roth IRA, you may be able to avoid both taxes and penalties if youve had the account open for at least five years and use it to fund a first-time home purchase.
As long as your Roth IRA has been established for at least five years, you can use that money penalty-free for a home down payment as long as it qualifies as a first-time home purchase, Levine says. The nice thing about Roth IRA withdrawal is that the contributions you originally make can be withdrawn for anything, at any time without penalty. Its when you get into the earnings that you run into trouble.
Roth IRA withdrawal rules allow you to take out up to $10,000 earnings tax and penalty free as long as you use them for a first-time home purchase and you first contributed to a Roth account at least five years ago.
If you withdraw more than $10,000 in earnings, you could run into issues, Levine says. He recommends consulting with a knowledgeable tax professional before moving forward, just to be clear on penalties and other consequences.
Youll also want to make sure you use your withdrawn funds quickly. Money must be used within 120 days for the purchase and it must go directly toward the cost of the home, or you may end up owing taxes and penalties, says Roberge.
How Do You Qualify For A Hardship Withdrawal
The IRS wont charge you a 10% penalty if you need to cover medical expenses. If you dont have medical insurance or sufficient cover, the IRS will allow you to withdraw without penalty.
The unemployed can withdraw some money to pay for medical insurance or bills, but only if you have lost your job rather than resigned. You also need to have been claiming unemployment benefits for 12 weeks continuously.
Even without meeting these hardship reasons, you could still withdraw without penalty. If you have no other way of paying higher education bills for yourself or a dependent, you could claim, for example.
Also Check: How To Take A Loan From 401k
Question : What Is Your Current Vested Balance
Your vested balance does not equal your total balance. Instead, this term refers to how much of your employer-sponsored plan would go with you if you were to leave your job or withdraw your 401 right now. While every dollar you contribute to your 401 is your money, the company-matching funds in your account are not immediately all yours. Every year, a certain amount of the matching funds is vested. Once youre fully vested, you can then claim the entirety of the employer match.
Note:Every employer is different with regard to the vesting period, and you will want to speak with your plan administrator if you have been with the company for fewer than six years . The IRS has a helpful entry on this topic.
Below is a snapshot of what Mark and Katies retirement plans look like:
| $8,198.23 | No Vesting |
Katie has been with her company just over two years and is only 20% vested. She also had a 401 at a previous employer rolled over into an IRA.
Two Ways To Use A 401 To Buy A House
Taking a 401 distribution
The first method you can use to borrow money from a 401k for a down payment is to withdraw money or take a distribution without intending to pay it back. Unfortunately, this method of using retirement funds to buy a house can have some expensive tax consequences.
While withdrawing from a 401 is always considered a taxable event, depending on your age, theres a good chance that youll be taxed on the same money twice. To start, all 401 distributions are taxed as ordinary income. However, if youre under the age of 59 ½, your withdrawal will be considered an early distribution and youll have to pay an additional 10% early withdrawal tax.
Using a 401 loan
Instead of withdrawing from a 401 for a house, it might be a better idea to use a 401 loan for your home purchase. As the name suggests, you have to pay back a 401 home loan eventually, but as long as you follow the rules, the money you borrow is not taxable. That fact alone can make it a more affordable option than taking a 401 withdrawal for a home purchase.
First, you have to pay attention to how much you can borrow. While not all 401 plans allow for loans, if yours does, youre allowed to borrow up to 50% of your vested account balance or a maximum of $50,000, whichever is less.
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How To Use Your 401 For A Down Payment
While its possible to fund a down payment from a 401, its generally not recommended. Still, if you want to proceed, there are two main ways:
These are the key differences between 401 loans and withdrawals:
| 401 loan | |
| Amount limited to the lesser of 50% of your vested account balance up to $50,000 | Cant exceed the amount needed to purchase your home |
| Might become due in full if you lose or leave your job | Not affected by losing or leaving your job |
| Not taxable unless you fail to repay it | Income tax is due on the amount withdrawn |
| No tax penalty unless it isnt repaid | Might incur a 10% early withdrawal tax penalty |
| Might not be able to make new contributions during loan repayment | New contributions can be made after |
Borrow Against Your 401
Borrowing from your 401 is generally the more advantageous option if you want to tap your plan for a down payment.
If your employers plan allows employees to take out loans against their 401 accounts, youll typically be able to borrow up to 50% of your vested account balance or $50,000, whichever is less.
Tip:
Youll then have to make more or less equal payments at least quarterly, with interest until youve repaid the loan. Youll typically need to repay it within five years.
Upsides
- Wont affect your credit
Downsides
Learn More: 401 Loans: Should You Borrow Against Your Retirement?
Read Also: Can A Qualified Charitable Distribution Be Made From A 401k
How To Use A 401 For A Home Down Payment
Buying a home is a significant part of the American Dream. But saving enough money for a down payment is usually the biggest obstacle for first-time homebuyers.
According to the National Association of Realtors, the average down payment on a home is around 11% of the purchase price. This translates to $33,000 on a $300,000 mortgage.
Eleven percent can add up to a significant amount of money. Plus, you will usually have to pay 25% for closing costs. The amount you put down will help determine your monthly payments, so it’s an important factor for homebuyers.
One method that some people use to finance their down payments is to tap into retirement accounts, such as a 401. There are two ways to use a 401 to finance a home purchase: borrow from it and withdraw money from it.
Here are the pros and cons of these two options.
Can You Use Your 401 Funds For Purchasing A Second Home Without Tax Penalties
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A 401 is a tax-qualified retirement account that provides tax benefits to employees and the self-employed. By charging a 10 percent penalty on early withdrawals, the accounts are structured to discourage you from withdrawing money before retirement.
Tip
You can use withdrawals from your 401 to purchase a second home, but you could be slapped with a 10 percent tax penalty. However, there are a several exceptions you might be able to use to sidestep the penalty. Withdrawals are not state-specific regarding penalties, but your state income tax may be affected.
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Can You Participate In The Hbp Later
If you are not considered a first-time buyer now, you may be considered a first-time home buyer later, once the four-year period has passed.
For example, if in 2014 you sold the home you lived in before, you may be able to participate in 2019 or if you sold the home in 2015, you may be able to participate in 2020.
Are You A First
Unless you are a person with a disability or you are helping a related person with a disability buy or build a qualifying home, you have to be a first-time home buyer to withdraw funds from your RRSP to buy or build a qualifying home.
You are considered a first-time home buyer if, in the four-year period, you did not occupy a home that you or your current spouse or common-law partner owned.
Also Check: Can You Convert A 401k Into A Roth Ira
K Withdrawal For Home Purchase Can You Use It
When deciding whether to use a 401K withdrawal for home purchase, there are many factors to be considered. Obviously, no one wants to remove money from a retirement plan. However, sometimes it is necessary. In this case, the biggest question becomes not whether you can, but what is involved, and what things should be considered prior to withdrawal.
Does A 401 Loan Or Withdrawal Make More Sense
When you consider the potential tax consequences associated with an early withdrawal, a 401 loan may seem more attractive. Of course, there’s one drawback with both options: you’re diminishing your retirement savings.
With a 401 loan, you’d have the ability to replace that money over time. If you’re cashing out an old 401, however, there’s no way to put that money back. In both cases, you’re missing out on the power of compound interest to grow your retirement wealth over time.
One upside of deciding to borrow from a 401 for a housewhether you take a loan or make a withdrawalis that it may allow you to avoid paying private mortgage insurance if you offer the lender a large enough down payment. Private mortgage insurance protects the lender, and it’s typically required if you’re putting less than 20% down on a conventional mortgage. Private mortgage insurance can be eliminated when you reach 20% equity in the home, but it can add to the cost of homeownership in the early years of your mortgage.
Also Check: What Is Ira And 401k
Retirement Accounts Can Be Tricky To Use
First and foremost, tapping into your retirement accounts today means you may have less when you do retire, especially when you consider how much compound interest adds up over time. “Most people have a tough time saving enough money for retirement to begin with,” Roberge says. Raiding your 401 or other retirement plans for a down payment can make it even more challenging.
There are also a lot of details to consider before tapping into your retirement savings. Rules such as penalties for making early withdrawals and time limits on 401 loans are designed to make it difficult and prompt you to think twice before accessing that money early.
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Still Not Sure Ask A Financial Advisor
For most home buyers, withdrawing or borrowing from 401retirement funds to make a down payment on a house is short-sighted.
But your personal finances may create an exception. For somepeople, a hardship withdrawal or 401 loan could be a sensible solution.
A financial planner can help you weigh your current accountbalance against your long-term financial goals so you can better decide how toproceed.
Consider using a Roth IRA instead
If you decide to use retirement funds to help buy a home, considerusing money saved in a Roth IRA instead of a 401 or traditional IRA. BecauseRoth IRA contributions have already been taxed, youll have an easier timeaccessing this money.
Also, since money in your IRA isnt connected to your employer, youwont face a faster repayment period if you change jobs.
Read Also: How Much Should I Put In My 401k
Buying A Home Is A Big Financial Investment And Even If You Dont Have The Cash To Purchase A Home Outright Youll Probably Still Need Money On Hand For A Down Payment
If you havent saved for a down payment, though, you might be considering other ways to get access to the money you need now, including your 401. Thats because some 401 plans let you borrow money from your retirement savings and pay it back over time.
But even if you arent planning to retire any time soon, taking a loan from your 401 can come with big drawbacks, like missing out on potential investment growth. So before you dip into your nest egg, consider if its really the best option for you.
Do People Really Make 401k Hardship Withdrawals
401k Hardship withdrawals have been on the rise. According to a study by Fidelity, 2.2% of all 401 participants had made a hardship withdrawal at some point over the preceding 12 months.
Thats up from 2% in the prior year and was the highest level in 10 years.
Are you thinking of becoming part of the 2.2%? Sometimes the withdraw rules can be confusing, so its important to know when you are allowed to pull money from your 401k because of hardship.
Read on to learn what actually happens when you make a 401k hardship withdrawal.
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Make Sure You’re Buying A Home For The Right Reasons
“Don’t buy real estate because rates are down or because of the pandemic buy real estate because it’s the best choice for you,” Roberge says.
Low interest rates don’t always add up to savings in your pocket. Over half of home offers tracked by Redfin in August were part of a bidding war, which can mean that the overall cost of the home is higher. While the interest rate may be low, if you’re paying a higher price overall to secure the home you want, it could end up costing you more in the long run.
If you’re considering buying a home in the current market, look at your savings levels before you browse listings, Roberge recommends. Do you have your cash reserves for emergencies set aside, plus money available for a down payment outside of your retirement savings?
“If not, it’s probably not a good idea to raid your 401 in order to make that down payment,” he says. That’s because when you take money out of your retirement accounts, it doesn’t “magically grow back,” Roberge says. “It’s money you’ve removed that you’ve worked so hard to save. By putting that money into real estate, it’s a coin flip on whether that’s going to be a good investment or not.”
When you’re buying a home to live in, it’s not an investment in the same sense as buying stocks, Roberge says. “It’s looked at as a utility. It’s a place to live…You’re building equity, which is a fantastic thing. But it’s not this secret solution that’s going to magically make your financial life better,” he says.
The Millionacres Bottom Line
To sum it up, you can’t purchase real estate directly with funds in an employer-sponsored 401k plan if you’re still an active participant in the plan. However, if you have money in a former employer’s 401k plan or are self-employed, there are some good options that can allow you to put your retirement savings to work in investment properties and other types of real estate investments.
Recommended Reading: Can I Borrow From My 401k To Start A Business
Should You Use A Roth Ira To Buy A Home
For the most part, experts say that using a Roth IRA to buy a home isnt the best strategyunless youre already saving a lot for retirement in another account and youre opening a Roth account specifically to save up for a home down payment.
But even if you keep contributing to another retirement account, taking money out of a Roth to buy a home incurs opportunity cost, Roberge says. While a home can be considered an investment, the overall returns on a primary residence arent likely to beat market returns, says Roberge.
You should be especially careful if you didnt set up your Roth IRA specifically for a home purchase.
If youre using the Roth because thats the only source of funding you have to make the purchase, that might be a red flag, Roberge says. If youre stretching yourself financially to buy a house, then buying might not be the best idea.
